This article will briefly explain a creditor’s rights with respect to collateral for a loan that is in default.
As a preliminary matter, no law provides what events constitute a default. Instead, the loan documents or agreements between the lender and debtor define the events that constitute a default. Once a default occurs, a lender has those rights with respect to its collateral that are provided by law, plus additional rights provided in the loan documents, subject to certain limitations imposed by the law.
After default, a lender may take possession of its collateral (other than real estate) without filing a lawsuit if the lender can do so without breaching the peace. A breach of the peace results from any act that is violent, or likely to result in violence. If a lender cannot obtain possession of its collateral without a breach of the peace it must seek judicial enforcement. As an aside, a creditor should take no collection efforts, event without a breach of the peace, during a bankruptcy without consulting legal counsel.
It is usually not a breach of the peace for a lender to load up a debtor’s car (if it is collateral) that is parked in the street in front of the debtor’s house. It usually isn’t a breach of the peace for a lender to pick up the debtor’s car in the debtor’s driveway if the loan documents give the lender permission to enter upon the premises (which they usually do). It may or may not be a breach of the peace to enter the debtor’s garage through a closed door to repossess the car. It probably is a breach of the peace to break through a locked door.
Repossessing the collateral over the debtor’s objection is a breach of the peace. Thus, if the debtor comes out of his house screaming as the lender is getting ready to load up the car parked in front of the debtor’s house the lender should cease its collection efforts and seek assistance from a court. In the absence of judicial process, the presence of a law enforcement officer does not cure what would otherwise be a breach of the peace. In fact, the presence of a law enforcement officer would seem to increase the likelihood that a breach of the peace has occurred since the officer’s presence makes implicit the threat of violent force.
A lender and a debtor may agree to the lender’s acceptance of collateral in full or partial satisfaction of the debt if no other person with an interest in the collateral objects within 20 days after notice of the proposal is sent to them.
Once a lender has possession of its collateral, it may sell the collateral pursuant to judicial sale, or in a commercially reasonable manner without judicial process. In the lender elects to proceed without a judicial sale, every aspect of the sale, from the determination to clean, repair or otherwise prepare the collateral for sale, to the time, manner, place and terms of the sale must be commercially reasonable. What is and is not commercially reasonable is a jury question, dependent upon the facts in each situation. If a lender fails to sell the collateral in a commercially reasonable manner, the lender will be precluded from collecting a deficiency judgment. A lender may purchase its collateral at a public sale, but only at a private sale if the collateral is of a kind that is customarily sold on a recognized market or the subject of widely distributed standard price quotations.
Prior to the sale of the collateral, the lender must generally send notice of the sale to the debtor, any guarantor, any other secured party and any other person claiming an interest in the collateral. The notice must be sent within a reasonable time before the sale. Notice sent at least 10 days prior to a sale is usually reasonable for collateral that is used for commercial purposes. Collateral that is for consumer or household use may require more advance notice. The notice must contain an identification of the debtor and the lender, a description of the collateral, the time, manner, place and terms of the sale, a statement that the debtor is entitled to an accounting of the unpaid indebtedness and the charge, if any, for an accounting. For collateral that is for consumer or household use, the notice must also contain the lender’s telephone and address for payoff information and a statement regarding the debtor’s liability for any deficiency.
A debtor, a secondary obligor, or any other secured party or lienholder may redeem collateral, generally at any time prior to its sale, by tendering full payment of all debts secured by the collateral and the lender’s reasonable expenses and attorney’s fees.
A lender shall apply proceeds from the sale of collateral in the following order to:
- Lender’s reasonable expenses (including reasonable attorney’s fees if permitted pursuant to the loan documents) of retaking, holding, preparing for sale, processing, and selling the collateral;
- satisfaction of obligations secured by the collateral;
- satisfaction of obligations secured by any subordinate security interest in or other subordinate lien on the collateral.
If the collateral is used for consumer or household purposes, and the debtor is entitled to a surplus or liable for a deficiency, the lender must provide the debtor with an accounting of the proceeds from the sale within 14 days from a request by the debtor or by the time of any demand for the deficiency by the lender. The accounting must include the amount of the surplus or deficiency, an explanation of how the secured party calculated the surplus or deficiency, an itemization of any expenses or fees of repossession and sale, an itemization of credits or rebates, any future debits, credits, charges, interest, rebates, and expenses that may affect the amount of the surplus or deficiency, and a telephone number or mailing address for additional information.
The debtor’s rights to notification of sale or a sale in a commercially reasonable sale can only be waived in a writing signed by the debtor after default. Failure to follow the notification and sale requirements can result in liability for damages or inability to collect any deficiency.
As reported in the Four Rivers Business Journal, February 2014